Archive for category Financial Policy
Our Inflation “Export” Will Almost Certainly Boomerang!
Posted by Tom in Economics, Fed, Financial Policy, Foreign Policy, Monetary Policy on January 18, 2011
Ron McKinnon, a Stanford professor and senior fellow at the Stanford Institution for Economic Policy Research, pens a brilliant history lesson in today’s WSJ, The Latest American Export: Inflation. In it he reviews three recent periods of “hot”money dollar outflows causing world-wide inflation.
“The hot money was caused by the Fed’s low rate easy money policy and consequent dollar depreciation. It flows out of the U.S. seeking higher returns. Foreign central banks intervene buying dollars to prevent their local currencies from appreciating. When central banks issue base money to buy dollars, domestic interest rates are forced down and domestic inflationary pressure is generated. Primary commodity prices go up quickly because speculators can easily bid for long positions in organized commodity futures markets when interest rates are low.”
McKinnon’s three periods:
- The Nixon shock when the U.S. abandoned the gold standard resulted in the surge of dollar prices of primary commodities.
- The Greenspan-Bernanke shock of 2003-2004 when the fed funds rate was reduced to 1% and followed by a falling dollar.
- And, the Bernanke shock starting in 2008 with short term rates at zero and quantitative easing (money printing) resulting in commodity price inflation in 2010 alone of over 30%!
Historically the remedies for this U.S. monetary folly, were not fun. Remember the “stagflation” of the 1970s, with inflation, unemployment, volatile exchange rates and little productivity? Well the cure came with Volcker at the Fed raising the fed funds rates drastically, touching 22% in 1981! And the Greenspan-Bernanke interest rate shock of 2003-2004 sowed the seeds of the weak dollar bubble economy in 2008. The biggest bubble was real estate with 50% increases in average home prices from 2003-2006!
Two lessons according to McKinnon: 1. Sharp price increases in auction-market goods like primary commodities is a warning sign that the Fed’s monetary policy is too easy. In 2010 CPI indexes shot up more than 5% in major emerging markets while only 1.2% in the U.S. 2. General price inflation in the U.S. “only comes with long and variable lags.” After the Nixon shock of 1971 inflation exploded in Japan in the 1972-1973 period but by December 1979 the U.S. CPI and PPI were higher than 13%!
In short, the inflation we ship abroad comes back to bite us where the sun doesn’t shine, and really bad!
In concluding commentary McKinnon points out that the U.S. can basically do what it wants, and since Bretton Woods has had the luxury of managing the world’s exchange and reserve currency. “But by ignoring inflationary early warning signs on the dollar standard’s periphery, which in turn lead to rising domestic prices and asset bubbles, the Fed has made both the world and American economies much less stable.”
Let’s hope Bernanke heeds the obvious. If not, we’re due for a repeat of the Carter years.
O’Driscoll Comments on Inflation
Posted by Tom in Economics, Fed, Financial Policy, Monetary Policy on January 13, 2011
Inflation is Here
January 13, 2011
by Jerry O’Driscoll
“Prices Soar on Crop Woes” reads the headline in today’s Wall Street Journal.
Global output of key crops such as corn, soybeans and wheat is down, and their prices are up, respectively, 94%, 51% and 80% from June lows. Today’s PPI report has wholesale prices up 1.1% in December after rising 0.8% in November. The Journal reminds us that in 2008 high food prices sparked riots around the world.
Meanwhile Fed officials tell us they don’t expect inflation. It is not an issue of expecting inflation, but of observing it here and now. The Fed prefers, of course, to look at “core” inflation rates, which are much lower. A former Fed colleague explained to me the central bank does so on the theory that people do not need to drive to work and can stop eating.
In our global economy, easy US monetary policy has thus far mainly affected commodity prices (including now food), real-estate in Asia and now broader price measures in Asia. It is implausible that the US would remain unaffected. Food, energy and clothing prices are all rising. I don’t think many households are presently gripped with a fear of deflation.
In the Mises/Hayek theory of economic fluctuations, the transmission of monetary shocks works through producer prices and incomes, and only later consumer prices. No measure of consumer prices, and certainly not a subset of consumer prices, is an adequate gauge of inflation.
Thanks to Jerry for republication of this ThinkMarkets post.
Gaping Hole in Financial Regulation
Posted by Tom in Centrally Managed Economy, Constitution, Financial Policy, Housing, Welfare on December 27, 2010
Tom Cargill has an excellent article in today’s RGJ, Reforming Freddie and Fannie is No. 1 Priority. In it he sets the record straight as to the causes of our current financial mess, “Incredibly easy monetary policy, lax regulatory oversight and flawed government incentives to expand homeownership to moderate- and low-income households based on “junk” mortgages are the source” of the Great Recession.
He correctly points out that the Democrats would rather point fingers elsewhere, Wall Street greed and deregulation. But these same politicians are responsible for the Community Reinvestment Act and the Fannie/Freddie subprime engorgement. Barney Frank famously wanted to roll the dice with F&F, he later admitted his error, after the international financial damage was done!
Tom rightly points out that the recently passes financial regulation failed to touch F&F, the prime cause of the Great Recession and that failure of courage must be remedied. Why? because they will continue down the same blind path if left to their own devices.
Housing has been a major economic driver as the baby boomers aged. It has been a first step toward everything in those new houses from beds to babies! The industry is in the tank now and hasn’t reached botton, again because of federal efforts to keep deadbeats in homes and prevent foreclosures. The overhang of underwater home mortgages is a major drag on home values. And until the secondary market reaches market clearing pricing, no upturn can happen.
Another downer is the maturity of the babyboomers. As that demographic lump passes from house to home to grave, the demand for housing will be less, absent some dramatic increase in immigration or fertility rates. So, the future does not look good.
But for the health of what will be left of the industry, the health of the economy, and the sanity of the financial markets, Fannie and Freddie must be dealt a death blow. The mortgage market must be allowed to operate in the private sector.
I have a basic prejudice toward government interference in free markets. Thus, I wonder what today would be like without the Community Reinvestment Act and without Fannie and Freddie? They forced or incentivised a large build up in the housing industry, misallocating investments and creating the bubble that burst. My gut is that we, all of us, would be much better off if they had not been around. And, where in the Constitution is there an enumerated power to promote home ownership to low income families or high income families for that matter? Truly beyond the scope of those powers. Something to think about!
Debt Problem? Solution: More Debt! And You’re A Lender!
Posted by Tom in Bankruptcy, Banks, Business, Deficit, Europe, Financial Policy, Foreign Policy, Monetary Policy, National Debt, State Finances on December 3, 2010
Makes absolutely no sense at all. Greece has a debt problem, can’t pay its debts when due; so the EU together with the IMF bail it out. How by lending it more money! Ireland has a problem, can’t pay its obligations when due, so the EU together with the IMF lend Ireland more money. Spain and Portugal see this and demand a larger bailout pool while the financial markets worry about “contagion.”
John Cochrane, a finance professor at the University of Chicago Booth School of Business, calls a spade a spade in yesterday’s WSJ op-ed, ‘Contagion’ and Other Euro Myths. The EU/IMF bail out facility promises that no sovereign bond holder will lose a cent at least for now. Basically what that says is that those lenders holding EU country debt now have a super guarantee. This is a guarantee to which they are not entitled. They did not bargain for this when they made the loans by buying the bonds. Their credit underwriting said that Spain, Greece, Ireland, and Portugal (the PIGS) were creditworthy at the interest rates charged. In short those lenders made underwriting mistakes.
So what happens when borrowers can’t pay? Normally, they restructure their obligations, sometimes extending maturities, and other times by having the principal balance reduced. In other words the lenders take a haircut. Why can’t this be done in Europe?
Now who are those dumb lenders, the sovereign bond holders, that the EU is so anxious to bail out? Well, they are the European and UK banks, principally those in France and Germany. To bail out dumb lenders or to guarantee them is bad policy. It denies the market discipline necessary for a functioning economy. It promotes moral hazard which simply means that those same lenders will not change their sloppy underwriting, will make more bad loans, and will expect future bailouts. Failure is just as essential to the marketplace as success.
As Cochrane points out the “contagion” boogyman is a myth: “The bailout is being justified on grounds of containing “contagion.” This is nonsense. The notion is that news of an Irish restructuring would scare investors in Spanish bonds, who would start looking at Spain’s ability to repay its debts and then demand higher interest rates.”
“But haven’t investors in Spanish bonds already noticed that there’s a bit of a problem? And wouldn’t news of a giant bailout make these investors question Spanish finances as much as would news of debt restructuring?”
“Any contagion is entirely self-inflicted. The only way Ireland’s fate affects Spanish investors is by changing the odds that the European Union (EU) will bail out Spain. And Spanish interest rates are rising, suggesting investors now think a Spanish bailout is less, not more, likely.”
On top of that all, U.S. taxpayers are putting money in to the unnecessary bailout facility. Yep, that’s right, the U.S. is the largest national contributor to the International Monetary Fund. So with our current weak economy, continuing deficits, and generation choking debt, we via the IMF are digging our hole deeper. The sad thing is that we have the ability to block the IMF action. But we don’t.
Question, will the United States face the same issues with our spendthrift sovereign states like CA, IL, and NY? Or will we get smart and (1) enact a state bankruptcy provision and (2) pass a constitutional amendment precluding bailouts? Something to ponder!
Bust ‘em Up
Posted by Tom in Banks, Economics, Financial Crisis, Financial Policy on December 2, 2010
Systemic risk is still upon us and is still real. The orgy of financial bailouts to sustain Wall Street has not changed the way big banks operate with our money. The Frank Dodd financial regulations law just passed did nothing to rein in the mammoth size of the big banks. And it is that size and the still viable risk-taking aspects of their businesses that causes “systemic risk.” Even after the recent bailouts, the five largest financial institutions are 20 percent larger than they were before the financial crisis, controlling $8.6 Trillion in assets. As a major part of the GDP, these firms are still too big to fail.
Clinton’s signature of the legislation repealing the Glass-Steagall Act which separated investment banking from commercial banking, was a mistake. The union of these two business functions one a risk taking trading business the other a money lending service business, generated large institutions that traded on taxpayer guarantees. In essence if they succeeded the shareholders won, if they failed the taxpayers bore the losses! While the Volker contribution to the recent legislation helped to mitigate this risk, it failed to eliminate it.
Thomas M. Hoenig, president of the Federal Reserve Bank of Kansas City, in his NYT op-ed, To Big To Succeed, argues that we still have large systemic risk and will continue to so have until the big banks are broken up. As long as the big banks know they are too big to fail, they will feel protected, take undue risks and jeopardize the American taxpayers. This moral hazard must be stopped.
“More financial firms — with none too big to fail — would mean less concentrated financial power, less concentrated risk and better access and service for American businesses and the public. Even if they were substantially smaller, the largest firms could continue to meet any global financial demand either directly or through syndication.”
While trust-busting is not in my libertarian blood, I am persuaded by Honig’s position. Trading on my tax dollars, with me only on the downside of the bet, is not just or economic!
Bust ‘em up!
Deficit Reduction-Competing Plans
Posted by Tom in Business, Centrally Managed Economy, Congress, Deficit, Democrats, Entitlements, Environment, Financial Policy, Foreign Trade, Government Regulation, National Character, National Debt, National Endowments and GSEs, Social Security, Taxation, Unions on November 17, 2010
Now we have another deficit reduction plan to compare the the Obama Deficit Reduction Commission plan, this the “Bipartisan Policy Center Debt Reduction Task Force” announced by Alice Rivlin and Pete Domenici. Here’s the WSJ high level comparison:
We won’t reduce deficits and their concomitant generation burdening debt until we reform congressional spending. Listening to another commission or task-force will not do the trick. Congress must get serious and tell the truth to the America people–there is no free lunch, THERE IS NO FREE LUNCH!
In addition to reducing the deficit, we must promote an environment for growth: certainty of taxation well into the future, certainty of limited regulation of business, and elimination of rent-seeking-giving subsidies and regulations.
All the principles of freedom and growth are anathema to the current state of Obamaism: Instead of reforming Medicare, Medicaid and Social Security Obama’s Democrats added Obamacare as an additional unsustainable entitlement with concomitant business and personal uncertainty. Instead of cleaning up the Fannie-Freddie generated financial mess Obama’s Democrats continued the charade of propping them up to do more future damage. Instead of cutting unnecessary spending, Obama’s Democrats passes such folly as cash for clunkers and bought GM for the UAW. So, bottom line, oppose Obama’s Democrats while they’re in office and turn them out of office ASAP.
A few basic economic growth imperatives;
- Repeal Obamacare while eliminating employer tax benefit subsidies, while eliminating interstate insurance competition barriers and while enacting stringent malpractice tort reform; reform Medicare over time as a high-deductible insurance policy with means testing; and reform Social Security with later retirement, means-testing and private accounts as an option for the means tested high-earners.
- Go for a flat, low-rate income tax both personal and corporate, eliminating extraterritorial corporate taxation, and all personal deductions, including home mortgage deductions.
- Eliminate all federal agency rule-making. If Congress can’t define it specifically as a law, then it should not govern, period! Now, there will obviously be extremely well defined and narrow exceptions to this like the difference in typeface, boldness or color of signs and warnings!
- Abolish all subsidies and mandates, farm subsidies/mandates, green subsidies/mandates, ethanol subsidies/mandates. If a product or service is not in and of itself economic enough or green enough to make it in the free market, then it should fail. In no case should it be subsidized.
- Eliminate all trade barriers that protect unions or their work rules. The Mexican trucking proscription under NAFTA is an example.
- Negotiate, sign and ratify as many free trade deals as are reasonable. As the world’s largest consumer, we hav the leverage, if we would only use it intelligently.
- Preclude all public service unions. Repeal Taft-Hartley and minimum wage laws.
- Eliminate all unnecessary government spending like, NPR, NEH, Department of Education, etc.
- Eliminate and forego all unfunded mandates to the states. Federalism must be re-energized and government pushed down to lower levels.
We need to get the point across to the American people that we are broke. We can’t afford the free lunches anymore. We need individual responsibility. We are not a socialistic nation.
In short, if we got government out of the way, this country would once again blossom!
Stratfor Dispatch: Currency War and the G-20
Posted by Tom in China, Europe, Financial Policy, Foreign Policy, Monetary Policy on November 10, 2010
Today’s Stratfor summary of the currency brouhaha is the best and most succinct I’ve seen in a while. I heartily recommend subscribing, http://www.stratfor.com
Here is the link: http://www.stratfor.com/analysis/20101110_dispatch_currency_war_and_g_20
Trade War With Major Supplier & Lender?
Posted by Tom in Deficit, Democrats, Economics, Entitlements, Financial Policy, Fiscal Policy, Foreign Trade, Monetary Policy, National Debt on October 11, 2010
Dee Woo, an economics professor in Beijing, suggests the futility of a trade war with China in his WSJ article, The U.S. Will Lose a China Trade War. He argues:
- Even if the Yuan appreciates the U.S. trade deficit will not reduce until we reduce our “chronically low”savings rate and diffuse the disincentive to manufacture.
- Washington can’t afford a weak dollar policy because the only thing standing between the U.S. and a Greek style sovereign debt crisis is the dollars status as a reserve currency. (CBO projects debt at 140% of GDP in 20 years!) Reserve currency status in not guaranteed!
- A strong Yuan would reduce Americans’ real income because it would kill U.S. jobs that depend on Chinese exports. The stronger Yuan will reduce China trade, thereby reducing Chinese trade surplus in turn reducing in recycled dollars reinvested in the U.S. promoting economic growth and lower interest rates.
- A strong Yuan would slow China’s rapid growth which is facilitating its transition from export dependency into a more balanced consuming nation.
- Finally, a strong Yuan would hurt and force out some export oriented businesses thus eliminating demand for excess low wage labor and disrupting China’s goal of attaining a “harmonious society.”
Monday’s paper details the planned continued pressure on China, U.S. to Step Up Pressure on China.” Direct pressure and international pressure on China will indeed continue. It has in the past led to small increases in the Yuan and no doubt will continue to do so. China may in fact revalue to a much greater extent, compelled to do so to control internal inflation.
But will this help a nation of spendthrift dependency brought about by the so called progressive leftists? And, how long will the dollar last as a reserve currency? The international confidence which made the dollar the reserve currency is evaporating. “As sound as a dollar” is sounding laughable.
Obama continues to borrow, tax and spend at an unsustainable pace. He and the Democrats added the unsustainable entitlement of Obamacare upon the unsustainable entitlements of Medicare, Medicaid and Social Security all growing out of control. The Fed’s continuing monetization of debt, devaluation of the dollar, reduces confidence, the confidence necessary to maintain the reserve currency status. This fiscal and monetary combination is a catastrophe.
Sad that Dee Woo’s arguments are probably correct!
Chilling Comparison-Will History Repeat?
Posted by Tom in Business, Economics, Education Facts & Policies, Entitlements, Financial Policy, Monetary Policy, National Character, National Debt, Taxation, Welfare on October 4, 2010
Donald Luskin, chief investment officer of Trend Macrolytics, LLC posted an interesting chart in his WSJ op-ed, The Trade and Tax Doomsday Clocks. It charts the Dow Jones Industrial Average in the 1930s against the same average from mid 2009 to today with the depression forward, 1932 to 1936, as a scary warning. Here’s the chart:
The article points out that Obama’s upcoming tax increase, allowing the Bush cuts to expire on those most able to invest productively, is dangerously close to the Roosevelt tax increases of the 30s. FDR tipped the economy into a “depression within a depression.” Obama is close to the same thing.
Luskin then shifts to trade noting that the House passed the “Currency Reform for Fair Trade Act” which adds dangerous new powers to the infamous Smoot-Hawley Tariff Act, the proximate cause of the Great Depression. This bipartisan vote is a shame. 99 Republicans participated in this homage to Herbert Hoover; they should know that his name “lives in infamy” for erecting those tariff barriers. Hopefully the Senate Republicans will hold out. If not, another source of economic growth will wither.
These observations alone are frightening enough, but when coupled with the WSJ front page article, Americans Sour on Trade, portend something akin to an upcoming depression. In essence a majority of Americans tend to favor protectionism or, at least, are against the economies of outsourcing. Understandably economic ignorance is prevalent, fostered by our leftist institutions of higher education. But, in fairness, conservatives have not convincingly explained the compelling economic benefits of free trade.
Finally and in nail-in-the-coffin fashion, we have the growing international trend of beggar thy neighbor competitive currency devaluations. Japan is the most recent example. The Fed with its impending QE2 threatened is another. What is the dollar worth, the pound, the Euro? If world trade stops or dramatically slows, depression or worse is assured.
I say that as a layman with no credentials. But it is becoming obvious that the socialized world cannot sustain itself in its current level of consumption without productive investment and growth. The U.S. is trending away from that growth regimen. Obama is penalizing productive investment and limiting growth by increasing the size of government.
So, we must economically educate the ignorant products of our universities, vote for leaders who have the guts to reform our unsustainable entitlements, and decrease the size and take of our government.
Meanwhile, one of my Irish friends sums it up nicely, “…guns and gold, Tom, guns and gold!”
Constitution? He Don’t Need No Stinking Constitution!
Posted by Tom in Business, Centrally Managed Economy, Congress, Constitution, Financial Policy, Government Regulation, Presidency, Statism on September 19, 2010
Our little dictator Hussein Obama really doesn’t want any “checks and balances” not even when his own party has complete control of them. Yep, Obama has appointed that darling of the left, Elizabeth Warren, “assistant to him and special advisor” to the Treasury Secretary with respect to the new Consumer Financial Protection Bureau. She will oversee all aspects of consumer protection including personnel and planning. The bureau has independent rule making authority and can grant itself an annual budget of up to $646 million from the operations of the Fed. No need of Congressional appropriations.
Instead of appointing her Director of the bureau which would have required the “advice and consent” of the Senate, he makes her a tzar answering to no one. She offices in the Treasury Department which has no authority over her. She will have “direct access” to the supreme dictator himself.
A WSJ editorial, Elizabeth III, pretty well sums up her power–and inferentially Comrade Obama’s power. No constitutionally required “advice and consent,” and no Congressional appropriations! Absolute rule making that can only be overturned by a 2/3 vote of the new Financial Stability Oversight Council.
The Constitutional requirements are pretty clear. Obama knows them. “On July 21, Mr. Obama signed a bill passed by both Houses stating that the “Director shall be appointed by the President, by and with the advice and consent of the Senate.” Yet he ignores them in the face of opposition from his own party. Democratic Senator Chris Dodd warned the president that she was not confirmable. Obama’s answer–take your Constitution and shove it!
This is so outrageous that even the liberal Washington Post editorial leads with “President Obama picks Elizabeth Warren…and thumbs his nose at the Senate.” It concludes, “for all intents and purposes, the president has created, and filled, a de facto directorship. This might have been in keeping with the letter of the laws, but not with their spirit.”
Now think for a minute the power this de facto dictator will have over fiance laws and regulations. It will cover not only banks but merchants extending credit. Think of the conflicts with banking regulations that are sure to occur. And finally, think of the business uncertainty compounded by the prospect of new regulations and new conflicts.
With the voracious trial lawyers waiting in the wings to sue banks and merchants for a misplaced comma or unbolded printing, expect a slow down in the extension of credit and a consequent slow down in credit dependent sales. Force these slow downs back through the chain of production and you have a general economic deterioration. All coming at a time that our recovery is very weak.
I can’t help but recall Tom Cargill’s chess match analogy: when the referee announced an impending rule change in the middle of the match, the players had little incentive to continue playing, so the match stopped! This is exactly what Team Obama is doing to our economy!